Europe's Problem, America's Solution

Greece has been out of the spotlight for a couple of weeks, which means it's
past due for another market-rattling announcement. And sure enough, today we
find out that its economy is shrinking even faster than expected:

This flew under the radar a little bit because we were all waiting with
bated breath for the pulse-pounding thrills of the latest FOMC statement,
but apparently Greece's economy is in even worse shape than realized.

"Who could possibly have foreseen that?" asked no one.

Nevertheless, it might be knocking the euro for another loop, although it's
tough to separate out the various actors hammering on the euro today, including
the overarching sense of disappointment with last week's EU summit, the results
of which are crumbling as we speak. Recently the euro was down to $1.3026
against the dollar, near its low for the day and pushing critical technical
levels.

This "news" has been discovered and reported by the bean-counting minions
of the Troika, who have taken on the thankless task of hanging out in sunny
Greece in winter to make sure it's holding up its end of the bailout bargain
by getting its fiscal house in shape.

"The International Monetary Fund sees the Greek economy deeper in recession
in 2011 than the government expects and a wider-than-forecast budget shortfall,
adding that the country has still a lot of work to do on reforms.

In a country review, the IMF said Tuesday the Greek economy is forecast
to contract by up to 6% in 2011, versus Greece's official estimate for negative
economic output of 5.5%, ahead of a downturn in 2012 in the region of 2.75%
to 3%. In its fourth year of recession, Greece has already revised lower
its growth figure to 5.5% of output for 2011 from a forecast of negative
3.8% earlier in the year."

What's more, Greece is not exactly rushing down the road to fiscal reform:

"Among the changes the IMF said Greece needs to adopt in order to return
to a growth path are shutting down inefficient state entities, reducing the
large public-sector work force, cutting public wage and pension levels and
stronger budget control.

'Greece is still well away from the critical mass of reforms needed to transform
the investment climate.'"

Here's a prediction: The Greek economy is going to continue to disappoint,
thanks to these austerity measures and the broader euro-zone recession

Meanwhile, the big European banks have been up to their usual oddly self-destrucitive
hijinks...

Many European Lenders Have Sold Sovereign-Default Protection to One Another

European banks do have insurance against sovereign-debt default, but they've
sold it all to each other, Laura Stevens reports on Markets Hub.

Dozens of banks across Europe have sold large quantities of insurance to
other banks and investors that protects against the risk of ailing countries
defaulting on their debts, the latest illustration of the extensive financial
entanglements among the continent's banks and governments.

New data released last week by European banking regulators suggest the risks
of banks suffering losses tied to European government bonds could be higher
and more widespread than previously realized.

The numbers show European banks have sold a total of €178 billion ($238
billion) worth of insurance policies, in the form of financial derivatives
known as credit-default swaps, on bonds issued by the financially struggling
Greek, Irish, Italian, Portuguese and Spanish governments. If those bonds
default, as some investors fear they might, banks could be on the hook for
making large payments to the holders of the swaps.

The banks have at least partly insulated themselves from such potential
losses by buying large quantities--roughly €169 billion worth--of credit-default
swaps tied to the same bonds, apparently in large part from other European
banks, according to European Banking Authority data.

The disclosures highlight another layer of risk interwoven through the continent's
banking system. Already, investor fears about the hundreds of billions of
euros of potentially risky government bonds European banks are holding have
eroded confidence in the industry, making it harder for many banks to finance
their daily operations.

Some analysts and investors say they had assumed that sovereign credit-default
swaps, known as CDS, were primarily sold by giant global investment banks
in the U.K., France and Germany, as well as in the U.S. Those banks sell
the swaps to big corporate clients and other banks and institutions.

But the new EBA data show a surprising breadth of large and small European
banks--at least 38 of them--have sold instruments that protect against potential
losses on Greek, Irish, Italian, Portuguese and Spanish government bonds.

Deutsche Bank executives say their positions are well-hedged and that they
buy CDS protection only from institutions based outside the countries in
which the bank is trying to buy protection. In other words, Deutsche Bank
wouldn't buy Italian swaps from an Italian bank.

WASHINGTON--A full-court press by Obama administration officials fell short
of its goals at the latest European summit, and the U.S. is once again pushing
euro-zone officials for a much stronger bailout fund to fight the debt crisis.

U.S. officials praised the deal reached Friday at a European Union gathering
in Brussels, which would tighten ties between the 17 nations in the currency
bloc. It would penalize members that fail to control their budget deficits
and would also put balanced-budget rules in place.

The U.S. hopes the pact will make further action by the European Central
Bank and other authorities more palatable down the road.

But the Obama administration was disappointed by the lack of progress in
bolstering the European bailout fund as the crisis roils financial markets
around the world.

U.S. officials want Europe to build a far more powerful firewall to keep
the crisis from spreading in the short run. More financial resources would
ensure that Italy, Spain and other major economies facing bond-market threats
could finance their governments at sustainable interest rates.

The efforts to forge the fiscal pact were "all for the good," President
Barack Obama told reporters here last week. "But there's a short-term crisis
that has to be resolved, to make sure that markets have confidence that Europe
stands behind the euro. And we're going to do everything we can to push them...in
a good direction on this, because it has a huge impact on what happens here" in
the U.S.

Officials across the U.S. government are in frequent contact with their
European counterparts. Treasury Secretary Tim Geithner conducted a rapid
run through five European cities in three days last week, meeting with officials
from four euro-zone nations and the ECB, all ahead of the EU summit. Vice
President Joe Biden met with Greek officials in Athens, while Mr. Obama continued
his phone calls to European leaders.

Obama administration and Federal Reserve officials see the euro-zone debt
crisis as one of the largest threats to the sluggish U.S. economic recovery.

With an election focused on economic concerns next year, the administration
fears that another downturn triggered by European turmoil could depress the
U.S. economy and quickly reverse the recent improvement.

In Brussels, European leaders last week agreed to introduce their permanent €500
billion ($669 billion) bailout fund in 2012, a year earlier than planned,
replacing a €440 billion temporary bailout facility. But they planned
no major expansion in the fund's total financial resources available.

U.S. officials want the continent to have much more firepower--perhaps $2
trillion or more--available to lend to struggling euro-zone governments.
They believe such vast resources would dissuade investors from betting against
the countries' debt and driving up their borrowing costs.

"The sums that you need for Italy and Spain are huge," said American Enterprise
Institute economist Desmond Lachman, a former IMF official. "You can pass
the hat around, but the real money is going to come from the ECB."

Some thoughts

Greece's finances are deteriorating...what a shock. Who in their right mind
would be building factories or hotels or hiring new workers there now? As government
layoffs rise and private sector hiring stagnates, tax revenues will obviously
contract and national finances will deteriorate. The only solution -- leave
the Eurozone, devalue massively and watch the tourists pour in -- threatens
the "insurance" that the big European banks have sold to each other and is
therefore unacceptable to the rest of the EU.

Speaking of credit default swaps, what do you think this means?: "Deutsche
Bank executives say their positions are well-hedged and that they buy CDS
protection only from institutions based outside the countries in which the
bank is trying to buy protection. In other words, Deutsche Bank wouldn't
buy Italian swaps from an Italian bank." Hmm...it's not clear that Deutsch
Bank buying insurance from Spanish banks to cover Italian debt, and then
from Greek banks to cover Spanish debt, is all that reassuring. The people
running these banks would be Darwin
Awards candidates if that organization had a finance category.

Meanwhile, "Obama administration and Federal Reserve officials see the
euro-zone debt crisis as one of the largest threats to the sluggish U.S.
economic recovery." It's only a threat because we're broke. If the US
had a healthy balance sheet, a European crisis would be a once-in-a-lifetime
buying opportunity. We could be like Warren Buffett, who builds up a mountain
of cash in good times and uses it to buy cheap assets when lesser mortals
go bankrupt. Instead we're so fragile that a few troubled banks 3,000 miles
away can send us into another Depression.

And about the US pressing Europe for bigger bail-out: Sometimes (okay, often)
it's embarrassing to be an American. Easy money is the heroin of the financial
world and we're the main pusher. Generally, the pusher wins arguments with
his addict clients, so expect a coordinated US/Europe quantitative easing that
dwarfs even the Fed's secret loan program of the past few years, and expect
it soon. Get ready, American and European taxpayers. You're about to become
proud owners of several trillion dollars of slightly used Greek and Italian
credit default swaps. Merry Christmas!

John Rubino edits DollarCollapse.com and has authored or co-authored five
books, including The Money Bubble: What To Do Before It Pops, Clean
Money: Picking Winners in the Green Tech Boom, The Collapse of the Dollar
and How to Profit From It, and How to Profit from the Coming Real Estate
Bust. After earning a Finance MBA from New York University, he spent the
1980s on Wall Street, as a currency trader, equity analyst and junk bond analyst.
During the 1990s he was a featured columnist with TheStreet.com and a frequent
contributor to Individual Investor, Online Investor, and Consumers Digest,
among many other publications. He now writes for CFA Magazine.